Sequestration's toll on industry is difficult to measure. Federal News Radio's special report, The Private Side of Sequestration, gauges the impact and ongoing effect of the Budget Control Act on the contractors that sell more than $500 billion worth of goods and services to agencies each year. We take an in-depth look at large, small and medium-sized companies, and investigate how government contracting is different today compared with previous fiscal years; which sectors are being hit the hardest; how business development is changing under sequestration; and how companies are planning for the future.

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Planning for the worst: Companies aim for sequestration-easing strategies

By
Jack Moore

Federal contractors may be feeling only a budget pinch
now, but sequestration — the automatic, across-the-board government
spending cuts that went into effect March 1 — could threaten to squeeze some
companies out of the industry.

In the first 2 1/2 quarters of fiscal 2013, the number of federal contract awards
fell by 32 percent compared to a similar stretch of time the
year prior, according to an analysis of federal procurement data
compiled by Govini. The total
value of awarded contracts also fell by more than 31 percent.

However, experts say there are strategies contractors can use to manage through
the cuts, including both long-term planning and short-term coping mechanisms.

Many companies are already doing so.

"Last year, around this time, people were looking at sequestration as something
that could be avoided," Kevin Plexico, vice president of information solutions at
Deltek, told Federal News
Radio as part of our multi-day special report, Private Side of Sequestration. "And now I'd say the
outlook is sequestration is most likely going to be sticking around. So, I think
companies are planning for the worst and hoping for the best, whereas last year
they were planning for the best and hoping to avoid the worst."

Companies need to reimagine, retool

With government spending declining and new business opportunities shrinking, many
companies will need to find ways to reimagine themselves and to diversify their
offerings into new business areas, experts told Federal News Radio.

Companies need to closely monitor how sequestration is affecting or will affect
their existing business opportunities, as well as how their partner agencies are
preparing for planned reductions, Plexico said.

"If you see a big impact, you have to start paying attention to where agency
spending is more liberal and not facing the same steep reductions," he said.

Sequestration is most likely going to be sticking around. So I think companies are planning for the worst and hoping for the best.

— Kevin Plexico, vice president of information solutions, Deltek

This so-called "white space" provides areas and opportunities where spending will
remain a priority and that haven't yet become over-saturated, he added.

This is especially important for DoD contractors who — even setting aside
the budget cuts stemming from the 2011 Budget Control Act and a second wave of
cuts from sequestration — would likely see diminishing contract
opportunities and revenues as the U.S. military disengages from the long wars in
Iraq and Afghanistan.

Companies are diversifying away from DoD "by necessity," said Tom Captain, vice
chairman of Deloitte LLP and the company's U.S. aerospace and defense leader.
"There's just not enough work to go around anymore."

For traditional defense companies, that means breaking out of their niches and
updating their portfolios of products and services to realign them with new
spending priorities. These include next-generation intelligence, surveillance and
reconnaissance tools as well as both offensive and defensive cyber capabilities,
Captain said.

Some companies are sticking with their traditional offerings, but shifting their
customers, Captain said.

For example, foreign military sales in emerging markets such as Japan, India and
Brazil, among others, are expected to increase and could help some big weapons-
makers make up some of the difference from declining U.S. sales.

Finally, some companies are expanding their non-government work, adapting
traditional defense technology for the commercial world.

One of the ways companies can quickly expand into new opportunities is through
mergers and acquisitions, Plexico said.

More than 34 percent of respondents in Federal News Radio's exclusive survey of contractors said their companies were engaging in
mergers and acquisitions to prepare for coming budget reductions, including 16
percent who plan to access new markets and 11.4 percent who want to grow their
contract bases.

But Plexico said the continuing climate of budget uncertainty could put a damper
on some industry moves.

"I'm probably going to be more inclined as a business owner to hold pat until
there's a bit more certainty and the valuations come up," he said. "The behavior
for most business owners would be, 'Why would I want to sell now when the market's
probably in the worst state it's been in the last 10 years and probably the worst
it's going to be for the next 10 years?' So, I might be inclined to hold out for a
couple of years and see if the environment improves before I sell."

Short-term strategies take aim at cost-cutting

Beyond diversifying — whether through acquisitions or organic business
development, both of which can take considerable time and resources —
companies can also put in place shorter-term strategies to better manage
the cuts.

Above all, companies are looking for ways to cut costs and reduce overhead, so
they can remain competitive in pricing, said Ray Bjorklund, president of BirchGrove
Consulting and a long-time analyst of the federal market.

According to Federal News Radio's survey, contractors are undertaking a number of
cost-cutting maneuvers. Sixty-three percent of respondents said their companies
were reducing salaries and benefits, including bonuses, to prepare for ongoing
budget reductions. About 36 percent of respondents said their companies were
cutting technical experts at their companies, while 28 percent said their
companies were cutting sales staff and business-development staff.

"One of the ways they can be more competitive is to have scale economy," Captain
said. "And the way you gain scale economy is through size — spreading your
overhead over a broader base. "

But companies won't survive sequestration only by cutting and thinking smaller.
They'll also have to think smarter.

The federal government is already looking for ways to shift contracting risk onto
contractors. The administration has made moving away from high-risk contracts,
such as cost-type and time-and-materials contracts, one of its top acquisition
priorities.

Companies, themselves, now have to find ways to manage risk, particularly in the
bidding process: "In pricing, in whether or not you submit a proposal and, even
earlier, whether or not you even write a proposal," Bjorklund said.

Overall, though, Bjorklund cautioned against thinking there will be a single
silver-bullet solution for contractors.

"I don't know that there's a panacea or a perfect solution to a lot of these
problems," he said. "There are just a lot of rational business decisions that
must be made."

For many companies, sequestration is arriving just when they have begun to dig
themselves out of the last financial crisis that roiled through the industry
— the 2008 recession.

But there's one big difference between then and now, and it could work in
contractors' favor, Bjorklund said.

"When government spending was contracting as a manifestation of the recession, it
was something that nobody could really put their finger on — it was kind of
intangible," he said. "And so a number of those large companies and business units
within those companies kind of put their heads in the sand."

Sequestration has been rearing its head for much of the last two years, and
lawmakers, industry CEOs and acquisition groups haven't been shy in raising the
alarm about the damage that could result from the cuts.

"When you start hearing those hard numbers, then it becomes much more evident,"
Bjorklund said. "And so, unlike the recession where some people were avoiding
addressing the problem so they could maintain their financial status, companies
now, I think, are taking a little bit more concrete action."